News & Insights

Softening Job Market

Federal Reserve Chairman Jerome Powell has become concerned about the apparent softening in the job market. He recently told Congress that the unemployment data sent “a pretty clear signal that labor market conditions have cooled considerably.” He can point to fewer job openings and a rise in the unemployment rate to 4.1%, up from a cyclical low of 3.4%. In addition, unemployment insurance claims have ticked up and full-time job growth has been paltry.

Much of the higher unemployment rate can be explained by an increase in the labor force participation (LFP) rate, which plummeted during the pandemic. The participation rate for those aged 25 to 54, prime working years, has steadily risen and is now higher than in 2019, boosted as new immigrants have entered the workforce. Keep in mind, only people actively looking for a job are counted as unemployed. As someone who wasn’t looking for a job begins looking for a job, they go from not being counted as unemployed to being counted. A rise in the LFP caused by this dynamic is very different from companies laying people off due to struggling profits and a stalling economy. The overall LFP rate has remained steady due to retirees. The labor participation rate for older folks, aged 55 and up, never rebounded and is now even lower than during the pandemic economy. Much of this trend is due to the bulge in the numbers of baby boomers retiring (approximately 11,000 turn 65 each day now). But some of the rise in unemployment is driven by job losses. A recent analysis from BCA shows that the number of people transitioning from employed to unemployed relative to the overall labor force is at unusually high levels.

Unemployment insurance claims have increased but are likely not as bad as the headline numbers suggest. While they are rising, most of the increase looks to be seasonal. BCA recently did a calculation of the insured unemployment rate, which is a proxy for the unemployment rate that doesn’t include new job seekers. The metric is only up marginally compared to previous years. Last week’s rise can be largely attributed to job losses following Hurricane Beryl and probably are temporary.

Though the data seem to convey only a modest cooling of the job market, there is some concern that the data may be faulty or understating weakness. Survey response rates are still very low, which increases error. The household survey, unlike the payroll survey, has showed no net growth in employment over the last year. Downward revisions continue to flag the more optimistic payroll survey, undermining the government’s projections of job growth this year. The Philadelphia Fed has showed that older payrolls were overstating job growth as more precise data come in. Also, the BLS uses a questionable model to predict additional entrances into the job market by estimating the number of new businesses created, known as the “Birth/Death Adjustment.” This model is prone to large errors and a lot of the employment growth has come from the model, not from the survey itself.

Percent Change in Employment Payroll Survey vs Household Survey (Top) and Payroll Revisions Since Initial Release (Bottom)

Source: Bloomberg

Monthly Transition from Employed to Unemployed as a Percentage of Labor Force

Source: BCA Research

Private Credit Opening the Spigots

As banks tightened lending to small businesses, there was a huge increase in credit provided by the private debt market, which is funded by pension plans and investments by wealthy families. This market for private lending remains healthy but is experiencing some worrisome trends, as higher rates challenge cash flows. Stressed borrowers are more frequently seeking covenant relief in 2024 but at levels still below pre-pandemic years. Credit measures for private-credit borrowers who are seeking relief have deteriorated (e.g., their interest-coverage ratio has plunged in just one year) and the loan default rate is on the rise. A substantial rise in direct lending refinancings may reflect lenders’ efforts to help borrowers avoid default.

The good news is that interest rates in this asset class have been coming down, and not just due to expectations of a falling fed funds rate, but also due to narrowing credit spreads. For instance, credit spreads of 600 basis points or more over SOFR (which closely tracks the fed funds rate) have tumbled from nearly 80% to 30% of newly issued sponsored direct lending between the second half of 2023 and the first half of 2024; many loans are now issued with spreads of less than 500 basis points. Competition has narrowed spreads, as borrowers are finding it much easier to secure financing from the recently reopened broadly syndicated loan market, which the banks shuttered following the stress from the pandemic. Even weaker credits that were shut out of much of the market until recently are getting financing now. Though some of the rate relief for borrowers is in the form of covenant relief as companies struggle to pay the onerous rates, overall, spreads coming in along with an open and liquid lending market is good news and welcome relief for many companies and for the economy as a whole. This is evidence of financial conditions continuing to be relatively easy despite the fed funds rate being in restrictive territory.

Frequency of Covenant Relief Rising but Remains Well Below Covid Peak

Source: PitchBook

Credit Metrics for Private Credit Borrowers Requesting Relief Have Deteriorated

Source: PitchBook

Deficits and Debt with No End?

The Congressional Budget Office reports on the U.S. fiscal situation make for grim reading. In June, the CBO shockingly raised its budget deficit forecast for the current year by $400 billion from its February projection, to $1.9 trillion, equal to 6.7% of the country’s GDP, a 25% increase in less than six months. The proximate causes of the widening gap in a halcyon time of economic growth and negligible unemployment include increased student-debt forgiveness, higher-than-anticipated Medicaid spending, $60 billion in aid to Ukraine and Israel, and higher inflation and interest rates (net interest payments are expected to reach almost $900 billion this year and top $1 trillion in 2025). The CBO projects that economic growth will slow from 3.1% last year to 2.0% this year due to weaker consumer spending and an expanding trade deficit stemming from rising imports.

The CBO’s revised 10-year budget and debt projections are a source of unremitting gloom. Just since February, the nonpartisan office has raised its baseline forecast for cumulative budgets deficits from 2025-2034 from $20 trillion to $22.1 trillion despite a modest increase in revenues. From this year, annual budget net interest payments are projected to nearly double to $1.7 trillion in 2034, and the quantity of debt held by the public is expected to zoom by 80% to $50 trillion in 2034, or 122% of GDP. It’s impossible to predict the path of politics and the economy going forward, but we can’t help but recall the plain-spoken wisdom of the late Herbert Stein, a prominent economist who served as chairman of the Council of Economic Advisers in the Nixon and Ford administrations: “If something cannot go on forever, it will stop.”

US Government Budget Deficit as a Percentage of GDP vs Unemployment Rate

Source: Bloomberg

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